# Basic Steps to Starting a Business

```Financial Ratios
In analyzing the financial statements it is common to use a number of ratios to determine what strengths or
problem areas a business might have. There are also ratios published for different types of businesses, which can
LIQUIDITY RATIOS
1.
Current Ratio = Current Assets
Current Liabilities
This measures the availability of liquid assets to meet current debts due within the year.
2.
Quick Ratio = Cash+Receivables+Marketable Securities
Current Liabilities
This measures the immediate debt paying ability of the business. The assets used in this calculation
are those readily converted to cash.
3.
Inventory Turnover = Net Sales
Inventory
This ratio indicates the number of times the inventory is replaced in a given period of time. This
gives an indication of how well the inventory is controlled. A slow turnover indicates that too much
is invested in merchandise. A high turnover rate reflects favorably on the business.
4.
Receivable Turnover = Net Sales
Accounts and Notes Receivable
This ratio indicates the number of times receivables turnover in a year. The higher the turnover, the
shorter the time between the sale and the collection of cash.
5.
Ratio of Net Sales to Net Working Capital = Net Sales
Net Working Capital
Net working capital equals current assets less current liabilities. Since working capital reflects the
ability to finance current operations, relating sales to Net Working Capital measures how efficiently
working capital is employed.
OPERATING RATIOS
1.
2.
Return On Equity (%) = Net Income Before Taxes X 100
Net Worth
The above ratio is your return on investment, the percentage of investment being returned through
profit. This ratio indicates the ability of management to increase stockholders investment.
Return on Assets (%) = Net Income Before Taxes X 100
Total Assets
This relationship of net income to total assets indicates the amount of income generated for every
dollar tied up in assets.
Small Business Development Center at the Santa Fe Higher Education Center 505-428-1343
3.
Fixed Asset Turnover = Net Sales
Fixed Assets
This is a measure of the capital investment needed to earn revenue. For example, a 1.0 turnover rate
indicates that company uses \$1.00 in capital to produce \$1.00 of revenue (sales).
PROFITABILITY RATIO
Profit Margin (%) = Net Income Before Taxes X 100
Net Sales
Profit margin represents the amount of profit resulting from each dollar of sales. For example, a 20% profit
margin indicates that for every \$1.00 in sales, a \$.20 in profit was generated.
Again, the ratios are useful in indicating a company’s financial position as related to others in a similar
business. They are also used to indicate historical trends within the same company; for example, are the
ratios consistent over a number of years, or are there points at which a change has occurred or is occurring.
Working Capital = Current Assets – Current Liabilities
Acid Test Ratio = Current Assets (Current Assets – Inventory)
Current Liabilities
Days Sales in A/R = Accounts Receivable
Net Sales
Days Inventory = Inventory
X
Cost of Sales
X Days in Period
Days in Period
Days CGS in A/P = Accounts Payable
Cost of Sales
X
Days in Period
Gross Profit Margin = Net Sales – Cost of Goods
Net Sales
Operating Expense Margin = Operating Expenses
Net Sales
Interest Coverage = Net Income Before Interest and Taxes + Depreciation
Interest Expense
Debt Service Coverage = Cash Flow from Operations
Interest Expense + Current Portion of LT Debt
Leverage Ratio = Total Liabilities
Total Equity
Small Business Development Center at the Santa Fe Higher Education Center 505-428-1343
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